The National Income numbers for 2016-17 have been released. What do they convey? What do they hold for the immediate future? Briefly, this is the picture. Recent revisions in the Index of Industrial Production and Wholesale Price Index do not alter the annual growth rates for the recent years.
The differences are in one or two decimal points. The growth rate for 2015-16 is estimated at 8%. The growth rate for 2016-17 is 7.1%, which is the same as forecast a few months ago.
Impact of demonetisation
It is the numbers for the fourth quarter of 2016-17, that is, for the quarter January-March 2017, which has attracted much attention. The numbers are being scanned with a critical eye to know what impact demonetisation had on the economy. The overall growth rate of GDP is 6.1%, which is nearly 1% below the growth rate for the previous quarter at 7%. The year-on-year decline is, however, steep.
In analysing the January-March quarter numbers, we need to keep in mind three factors. First, a decline in growth rate has been seen from the beginning of the year. The growth rate of every quarter has been sliding from the previous quarter. Second, during Quarter 4, the only two sectors which have shown strong growth are agriculture and public administration. Public administration, defence and other services have shown a sharp increase of 17%. But for this, the overall growth rate would have declined steeply. Third, the sectors that have shown a sharp decline are construction and trade, hotels, transport and communication. These are the sectors which use cash extensively. In the case of construction, output actually declined by 3.7% as compared to a rise of 3.4% in the previous quarter. However, the decline in construction should be interpreted carefully.
Obviously the liquidity crunch brought about by inadequate availability of currency consequent upon demonetisation must have halted a lot of construction activity immediately. But the decline is also partly due to ‘shock effect’. After all, the construction and real estate sectors are notorious for their cash transactions and dealings which are not above board. There is a paramount need for the participants to adjust.
It is naive to pretend that demonetisation would not have had a short-term disruptive effect which would adversely affect growth. The long-term benefits in terms of a change in mindset and behaviour of people and greater use of technology-driven payments system are in the future. They need further actions.
Fast remonetisation will help to eliminate the adverse effects caused by shortage of currency. The authorities also need to augment the supply of ₹500 notes in a big way.
While decreased use of currency is a desirable goal, the authorities should not proceed on the assumption that it is actually happening and therefore the supply of currency can be reduced. While the adverse effects of demonetisation on GDP are clearly seen, it is difficult to decipher how much of the decline in growth rate in the January-March quarter is due to demonetisation and how much due to the underlying declining trend. Now that the disruptive effects of demonetisation are behind us, we need to explore the other factors that may be holding growth back. The most disturbing aspect of the data just released is the continuing decline in the Gross Fixed Capital Formation (GFCF) rate, that is, GFCF as a proportion of GDP. It has been steadily declining and in 2016-17 it fell to 29.5% from 30.9% in 2015-16.
Role of new investment
In the days of high growth, it hovered around 33%. In recent years an attempt has been made to raise public investment. In fact, this effort, combined with some improvements in the efficiency in the use of capital, has led to significant improvements in the output of coal, power and roads. This is necessary and must be continued. But the ultimate answer lies in the pickup in private investment.
There is a general concern that despite reasonably high growth (the average growth of GDP for the three years beginning 2014-15 is 7.5%), job creation has been modest. Growth can happen because of greater utilisation of existing capacity or new investment. Job creation in the first case will only be modest as is happening currently in India.
It is only new investment that will push growth and that will generate greater employment. Obviously, there are many other factors such as technology that play a key role in determining the level of employment.
For sustained high growth, we need new investment and policymakers must shift their focus towards this. In fact, foreign direct investment has been very high. Despite this, the rate of growth of fixed capital formation has been weak. The sentiment, it is generally believed, has changed. The reform agenda has been pushed forward. The Bankruptcy Code has become operational. The Goods and Services Tax will very soon come into force. The FDI rules have been considerably relaxed. All these are welcome steps. It will, however, take some time before the impact of the first two is felt on investment and growth.
Burden of debt
Perhaps one of the reasons for investment not picking up is the burden of debt under which Indian businesses are suffering. The banking system is also under stress. The health of the banking system is closely aligned to the health of the private sector business, both corporate and non-corporate.
The sooner we resolve the problems of the banking system, the better for the economy. It is the resolution of the NPA (non-performing assets) problem that will enable the banks to restart their lending programme in a big way and help business to embark on new investment. The macroeconomic stability parameters are in good shape. Prices are under control. The Central government fiscal deficit is adhering to the road map laid out in the Budget. The balance of payments situation is also under control.
The monsoon is expected to be normal in the current year. This is the appropriate time to convert sentiment to firm action with a big push on private investment. Like law and order, social harmony is also a necessary prerequisite for faster growth. Ignoring this will bring to naught all other economic initiatives.
C. Rangarajan is former Chairman of the Economic Advisory Council to the Prime Minister and former Governor, Reserve Bank of India
